Original author: Maxxx (X: @Max_Sunxxx )
A confession from a frontline market maker, a guide for project owners to save themselves in the dark forest, I hope it will be of some help to you:)
Let me introduce myself: I am Max, a post-00s who feels very old. I was originally a poor finance student in Hong Kong, but I have been in the cryptocurrency circle for 21 years (thanks to the industry for saving me). Although I have not been in the industry for a long time, I entered the industry as a project party at the beginning, and later started my own business to build a developer community and accelerator, which can be regarded as being close to first-line entrepreneurs. Now I am in charge of our market maker business line at @MetalphaPro . Thanks to the boss for giving me a title of Head of Ecosystem, but in fact I am responsible for BD and sales. In the past year or so, I have been in @binance , @okx , @Bybit_Official and second-tier exchanges. In total, I have handled the listing and subsequent market making of more than a dozen coins, which can be regarded as some shallow experience.
It has been a turbulent time recently, and the topic of market makers is also at the forefront. I have always wanted to systematically talk about the special role of market makers in the industry. I just took this opportunity to do some sorting. I am not good at business, so please forgive me if there are any omissions. This article only represents my own views and is 100% from my own hand.
Attached is a photo of my dog
Let’s start with the GPS “observation tag”…
When I heard that GPS was put on the observation tag by @binance , I was chatting with the founder of a project who I had known for more than a year and who also planned to list the coin in Q2. This guy is very young, handsome and capable, but you can hear that his tone of conversation is full of fatigue - the project has raised several Mils and achieved some good results. Everything seems to be going smoothly, but for the founder, the funds raised are actually debts. He has been pivoting for more than a year. The market is so difficult. On the one hand, he is trying to close a new round of financing, on the other hand, he is in difficult negotiations with first-tier exchanges, and on the other hand, he is watching the tokens that have broken their issue prices recently. He is worried about whether the coin price can perform well after being listed on the exchange, and how to explain to investors. The pain, worry and confusion are only understood by friends who have worked on projects... Just as we were chatting about this and that, Binances notice suddenly caught our eyes. Although we did not have any market-making cooperation with the project, it happened that we have had some contact with the team members in the past two years, and we were instantly filled with emotion.
I won’t make too many comments on this matter, as it’s annoying to talk too much. I’ll wait for the notification and announcement from Binance and the project team. But in the past two years, I have indeed seen too many project teams and retail investors being cheated by market makers. I just took this opportunity to write this article, hoping to help project teams and friends in the industry. Okay, no more nonsense, let’s get to the real stuff.
The business model of market makers: Not as magical as rumored, just a placer
Market makers are not a new term in crypto. There are also market makers in the traditional financial industry, but this service has a more relaxed name, called Greenshoe (because in 1963, the Boston Greenshoe Company in the United States used this mechanism for the first time during its IPO). Although the mechanisms are slightly different, the responsibilities are basically the same, which is to make bilateral bids and asks at the time of IPO to maintain market liquidity and relatively stable prices. However, due to strict compliance supervision, the green shoe business is a very standard trading desk branch business without much oil and water. Even no large trading desk will take it out for PR to say that we do this. But the irony is that such a standard business has become a sickle in the minds of many people in the crypto industry that can control the market and call the wind and rain.
However, if market makers really follow the industry norms to provide liquidity, there is really no such thing as a sickle. The so-called liquidity provision is mainly to make bilateral quotations on the trading platform. Of course, the broad market makers in the crypto industry have some other categories and businesses. Today we will only focus on the narrow category that is most closely related to everyone, serving the project partys tokens, which can be roughly divided into the following business models:
Active Market Maker
In fact, the demonization of market makers in the industry largely comes from the existence and operation of active market makers in the early days of the industry. There is a saying in Cantonese, making a kitchen, and in Mandarin, it is called making a bank. Active market makers satisfy all the markets fantasies about market makers. Generally, active market makers will cooperate with project parties to directly manipulate market prices, raise or suppress prices, and seek profits from them, harvest retail investors in the market, and share profits with project parties. The terms of their cooperation are also varied, involving different models such as borrowing coins, connecting to APIs, allocating funds, and profit sharing. There are even cases where wild dealers do not communicate with project parties, directly use their own funds to grab chips, and operate the market themselves after grabbing enough chips.
What are the active market makers in the market? In fact, the active ones in the market are more famous for PR and organizing events. The market makers whose names you have heard of are all passive market makers. At least everyone must claim to be so, otherwise there will be compliance issues, not to mention doing marketing in a swaggering way (but it does not rule out the possibility that some market makers have done some active cases in the early days of the industry, or are still doing it secretly).
Most active market makers are very low-key and have no names because they are not compliant. As the industry gradually becomes standardized, ZMQ and Gotbit, which were previously high-profile, were named by the FBI and fell into serious compliance troubles. The remaining active market makers have also become more anonymous. Some of the big ones have done some so-called successful cases, so they have status and most deals are made through referrals from acquaintances.
Passive Market Maker
Passive market makers, including ourselves and many other friendly companies, belong to this category. Their main job is to place maker orders on both sides of the order book of centralized exchanges to provide market liquidity. There are two main business models:
Token Loan
Retainer (monthly fee)
Token loan
This is the current mainstream and most widely used cooperation model. In short, it is a model where the currency is lent to the market maker for a certain period of time, and the market maker provides market making services.
A typical token loan deal consists of several aspects:
Borrowed Token Amount x%: Usually a percentage of the total token supply
Borrowing period x months: The borrowing period. When the service ends, the settlement will be made according to the signed option.
Option structure: The delivery price that the market maker sets when the service expires.
Liquidity KPI: The market maker will set the order depth on the market, which may involve different exchanges and different price ranges.
How do market makers make money under this model?
Market makers make money from two sources. One is the price difference between buy orders and sell orders during the market makers order placement process, which is generally a small part. The other is the options given to the market maker by the project party, which is generally a relatively large part.
Friends who are familiar with finance may know that every option has value on the first day of signing the contract. This value is a percentage of the value of the borrowed currency. For example, if I borrow a total of 100 wU of currency, the value of this option is 3% on the first day. That means that if I strictly follow the algorithm (delta hedge) to place orders, I can realize a relatively certain return of 30,000 US dollars. Then under normal circumstances (extreme situations such as currency prices soaring or quickly returning to zero are not counted, and effective delta hedge cannot be performed in such market conditions), the profit of the trading desk signing this cooperation is 30,000 US dollars + some money earned from the price difference when placing orders.
Do you feel that market makers do not make as much as you think? But in fact, the profit margin I mentioned is not completely out of touch with reality. Market makers are also very competitive at the moment, and the competitive option prices are becoming less and less inflated.
Retainer (Monthly Fee Model)
This is the second relatively mainstream model at present, which means that the project party does not lend the currency to the market maker, but keeps it in its own trading account, and the market maker makes the market through API access. The advantage of this model is that the currency is still in the hands of the project party, and all operations in the trading account are open and transparent to the project party. In theory, the project party can withdraw funds from the account at any time, so there is no need to worry about the risk of market makers doing evil. However, in this model, the project party needs to prepare tokens and U in the account for bilateral orders, and generally pay the market maker service fee on a monthly basis.
In this case, the market maker places orders according to the clients liquidity KPI and earns the monthly service fee. The funds in the account have nothing to do with the market maker. In extreme cases of poor liquidity/speculation, placing orders will result in losses, and these losses are also borne by the project party itself.
I think both Token loan and Retainer have their own advantages and disadvantages. Some trading desks only focus on one of them, while some like us can do both. Project parties should choose according to their needs and project conditions.
Several common misunderstandings
Market makers are responsible for “pulling the price”, “drawing the line” and “building mouse positions”
Qualified passive market makers are neutral and will not actively participate in pumping, market value management, or harvesting.
Market makers provide liquidity, which is called washing volume
There are two types of orders in the order book of the exchange, one is the maker order and the other is the taker order. The main thing passive market makers do is to place maker orders, and the proportion of taker orders is very small. A good cook cannot cook without rice. No matter how deep the maker orders are placed on the market, if there is no counterparty taker to trade, it will not directly increase the trading volume. However, if the left hand guides the right hand to trade its own maker order, that is, self-trading, there will be compliance risks, and the top exchanges will also strictly investigate such behavior. If the proportion of self-trading is too high, the market maker account and tokens may face warnings and handling from the exchange.
It sounds like passive market makers are useless?
Not directly responsible for the price of the currency, not directly responsible for the trading volume, it sounds like it is useless. But good liquidity is the cornerstone of everything. Small-scale money focuses on the price trend of the currency, and the first thing that large-scale money looks at is the trading volume and depth. A token with active trading and healthy currency price is closely related to the product strength and marketing ability of the project party, and it does require close cooperation from market makers. Even if we take a step back, the top first- and second-tier exchanges will rarely let you list the currency without professional mm, otherwise it will be a mess when the market opens, and mm must register in advance. So at this stage, cooperation with passive market makers is still a step that every project party that is listed on the top CEX must go through.
It sounds like market makers just place orders, and the threshold is not high. Can the project party do it themselves?
Yes and no. If you do have a proprietary trading team and the project is relatively large, some second-tier exchanges may allow you to do it yourself. But if you don’t have one, or if you need to build a new team, I suggest you leave professional matters to professionals. On the one hand, the cost and risk of building a team is not as good as finding a reliable market maker. On the other hand, if you are not familiar with mm, you will really lose a lot of money when placing orders yourself in the face of various extreme market conditions.
The ecological position of market makers: opening liquidity is the most valuable resource
After explaining the business model, let’s talk about the current situation, which may help you understand it better.
What will the cryptocurrency world look like in 2024-2025? From a liquidity perspective, this is how I see it:
BTC has an independent market and has been rising all the way. The liquidity at the top is sufficient. There has been a pullback recently, but it does not shake the foundation. The mining costs of miners are all in the 5-digit and 6-digit range, and they are very happy. The traditional institutions that rushed into the market are also very happy.
The PVP at the end was fierce, and liquidity was relatively sufficient. The young players on @pumpdotfun , @gmgnai , @solana , @base and @BNBCHAIN were addicted to losing money (I also contributed a little, damn it), and the outliers and insiders were happy to make money.
The liquidity in the middle part is exhausted, with the Trump and Libra wave as the peak, which almost drained the liquidity and buying power in the middle part, and structurally and irreversibly sucked it from the inside to the outside. The positioning of tokens with a market value of hundreds of millions to billions is awkward. No one buys the newly launched tokens on the first- and second-tier exchanges. The trading volume of the tokens dropped sharply within two months after they were launched. Most of the trading volume and depth occurred at the opening, and they soon fell below the primary price of VCs. There is a high probability of losing money when the VC is unlocked, and a high probability of returning to zero when the team token is unlocked.
In this cycle, these mid-level tokens seem to have the hardest time. But another cruel fact is that more than 90% of the so-called web3 native practitioners in our industry are the practitioners who actually receive wages, run conferences, and do business every day, including VCs, project parties, accelerators, BD, markets, development, etc. Everyone is doing the business of mid-level tokens. You see, a series of behaviors such as investment and financing, product development, marketing, haircuts, and listing on exchanges are actually centered on these mid-level project parties listed on centralized exchanges. Therefore, in this cycle, many practitioners did not make money and had a hard time.
I think that only market makers hold the most scarce resource of mid-tier tokens: opening liquidity. Yes, liquidity alone is not enough. Liquidity must come early and must be available at the opening. Otherwise, when the project returns to zero, no matter how many coins you have, it will be useless. For example, if a project opens with a circulation of 15%, there will always be 1 to 2 points, or even more, given to market makers. These liquidity unlocked at the opening is an extremely valuable resource under the current market conditions. Therefore, not only are market makers becoming more and more involuted, but many VCs and project parties have also temporarily set up teams to start MM. Some teams do not even have basic trading capabilities, but they still take the coins first. Anyway, they will return to zero in the end, so there is no fear of not being able to redeem.
The dark forest where bad money drives out good money: the honest and giving personality cannot defeat the scumbag
Under such market evolution, a very unique ecosystem of market makers has been formed today: on the one hand, there are more and more market makers, and the quotes are involuted to an outrageous degree; on the other hand, the service quality and professional ability vary greatly, and various after-sales problems often occur, the most common of which is the withdrawal of liquidity and default. First of all, it is clear that market makers are not forbidden to sell coins. In fact, if the coin soars, the order placement according to the algorithm will be biased towards the selling direction, because I borrowed coins, and the final settlement with the project party is U (if you don’t understand, you can read the token loan option part again). But a qualified passive market maker should place orders normally according to the algo, instead of acting as a taker and smashing the market. Such operations are extremely harmful to the project.
Why do market makers do this? Back to the option part we just talked about, a market maker gets the token loan quota and places orders according to the normal algo. If the market has been tepid, he should successfully realize the value of the option and earn 3%. But if he believes that the project will return to zero when the settlement expires, he can realize 100% of the profit by smashing it at the opening, which is 33 times the normal profit of mm. Of course, this is the most intuitive and extreme example. Most real operations will be much more complicated, but the underlying logic is to be bearish on tokens, sell them in advance when the price is high and the liquidity is good, and buy them back for settlement when they expire.
Of course, in addition to being unethical and non-compliant, doing so also carries additional risks. On the one hand, market makers are completely unable to provide liquidity according to KPIs within the contract period because they do not have a healthy inventory. On the other hand, if the token is bet on the wrong direction, a lot of money will be lost and there will be no way to redeem it.
Why is this behavior so common?
The compliance of the industry is still in its early stages. As far as the token loan model is concerned, although market makers will report service conditions to project parties through daily reports, weekly reports, dashboards, etc., and there are third-party supervisory agencies and tools in the market, what the currency does in the market makers account is still a black box, and the market lacks effective supervision methods. After all, the only ones who have solid evidence and can see every trade of the market maker are centralized exchanges themselves, but many market makers are V 8 V 9 customers of centralized exchanges, bringing hundreds of millions of handling fees and capital to the exchanges every year. Exchanges are also obliged to protect the privacy of their customers. How can they disclose their transaction details to help project parties protect their rights? Speaking of this, I cant help but admire @heyibinance @cz_binance s vigorous and resolute actions. I remember that this is the first time that the transaction details of market makers have been fully disclosed, including the time, operation details and cash-out amount accurate to the minute. Whether such behavior should be done is worth pondering, but the original intention must be good.
The project parties and the entire industry still need to strengthen their understanding of market makers. In fact, what surprised me was that I talked to many bigwigs in primary investment, founders of projects that raised tens of millions of US dollars, and even practitioners in exchanges, who didn’t know much about the business of market makers. This is also an important reason why I started writing this article. Because most project parties are actually first-timers, but market makers are scumbags who have experienced many battles. As a front-line practitioner, sometimes when I see project parties choose the so-called better terms, I will also ask myself, should I also match the outrageous terms offered by my friends and get the deal first? In this dark forest of market makers, it is difficult to keep the bottom line. Scumbags who pretend to be profound are always more attractive than honest people. Only when everyones understanding of the industry is aligned can we avoid the situation where bad money drives out good money.
How do you choose your market maker?
There are a few questions and tips that I think are important.
Is it true that we cannot choose to take the initiative?
In fact, when the project party asked me this question, I would not directly and arbitrarily say not to choose it. If we put aside compliance, I think this is an issue worth debating. Some projects have indeed brought better-looking charts, more trading volume, and more cash out through close cooperation with active market makers, but of course there are countless failures. I just want to express a point of view here. You have to realize that those who can help you pull real money will also be mercilessly cut, and the liquidity of the market is so much. At the end of the day, you are the counterparty relationship, and the money in the market is either earned by you or your active market maker.
Should we choose token loan or retainer as the cooperation method?
Currently, the token loan model is still more mainstream, but the market share of retainers is slowly increasing. This is a question of taste and demand of the project side. For example, the project side that strongly controls the fundraising may not want to have uncontrollable large-scale liquidity from the outside.
Try not to choose only one passive market maker
Don’t put all your eggs in one basket. You can choose 2-4 market makers and compare terms with each other. If one market maker goes down, there are others to fill in. In addition, in order to win the deal, market makers will usually propose various additional value adds. Choosing more market makers can help you. However, in order to avoid the problem of three monks have no water to drink, it is recommended to assign market makers to different exchanges. Mixing them together will make it more difficult to monitor.
Don’t just choose your market maker by investing
You can accept investment from market makers, and more runway is always good. But you also need to understand that market makers’ investment and VC investment are not the same game. Because they control a considerable amount of opening liquidity, market makers have a way to lock the price, hedge, etc. of the coins they have invested in but have not yet unlocked. Therefore, it is not necessarily 100% a good thing for the project party that market makers have taken token loans and have a considerable amount of token investment positions.
Don’t choose your market maker based solely on liquidity KPIs
Liquidity KPI is difficult to verify in practice, so don’t choose market makers based solely on liquidity KPI. No matter how beautiful the terms are, they are useless if they cannot be implemented. Before you lend the currency, you are the father. Once the currency is lent to the market maker, you become the son. They have many ways to fool you.
Change your mindset: Become a scumbag yourself
Remember that you are the party A. Before signing the MM, compare the terms, discuss how to monitor, how to prevent the market maker from defaulting, and choose a solution that suits your project development. You can use the terms of one company to pressure another, so that you can compare prices back and forth. There should be no ambiguity in the terms. If there are unclear points, dont figure them out by yourself, just ask directly.
A little bit of emotion
I am a junior in the industry, and I cherish the opportunity to feel and touch the industry in such depth. I often feel the dirtiness and chaos of the industry, but I also feel the vitality and vigor at all times. I never think that I am the smartest one. Many young people of the same age in the industry are excellent, and they quickly find their place, but more young people are actually confused. If there is no web3 industry, it is difficult to find a way to rise.
I also have a boss with very positive values and a highly professional trading team as the backend. The stable asset management business allows us to make friends with the market-making business instead of relying on the market-making business. I have also been following my own pace and the logic of making friends with project parties. I have missed some deals and also talked about a few deals that made me proud. Although some projects did not become deals, I became friends with the project parties.
I have talked a lot and I was very conflicted in the process of publishing this article. On the one hand, I was afraid that I was not good at my job or that I could not express myself well, which would mislead the project parties and readers. On the other hand, market makers have always been very secretive in the industry, and I was also afraid that I would not be able to grasp the scale when talking about these things and would affect someones business.
But I really believe that as the industry develops and compliance gradually becomes the mainstream, one day, the role of market makers will no longer be demonized and will return to the sunshine. I hope this article can play a role to some extent.
Friends I made :)
